“The suggestion to use 401(k), 403(b) or retirement savings to get out of debt is usually shared by well-meaning relatives of indebted consumers who don’t want to be tapped for help,” says Linda Humburg, a counselor manager at FamilyMeans Consumer Credit Counseling Service. This advice raises alarm for a few reasons, Humburg says, one of which is that “it’s often suggested as a first option and doesn’t necessarily resolve the consumer’s financial problems.”
Instead, tapping retirement funds to pay off unsecured debt should be a last resort that comes only after a borrower has considered all other options, including bankruptcy.
It’s deceptively easy to view retirement funds as a piggy bank that will solve a debt problem, Humburg warns. “Too often, consumers are not prepared for the future tax liability based on the fund withdrawal,” she says. In addition, without an overhaul to a borrower’s spending behavior, the underlying financial problems are unlikely to be resolved.
“Add to this the unlikely ability to rebuild those funds,” Humburg points out. “They’ll never recapture that starting base with 15 to 30 years of growth,” which will leave you worse off when you do want to retire.